Why You May Want to Sit Today Out

by Sam Collins | July 12, 2011 2:00 am

Stocks were lower again yesterday, as investors put the U.S. budget deadline on hold and focused on Europe and the possibility that a bailout there might have to include Italy. The selling was most pronounced in the financial stocks, which fell almost 3%. The Nasdaq lost 2% for its worst day in over a month, and the Russell 2000 was off 2.23%.

In Monday’s Daily Market Outlook[1], I noted that “The major indices took on the appearance of the Nasdaq chart — all failed to breach the early May high.”

This is a short-term disappointment, and yesterday’s selling is technical confirmation that the next support for the major indices is at their 50-day moving averages. For the Dow Jones Industrial Average, that number is 12,371, for the S&P 500, it is 1,300, and for the Nasdaq, it is 2,763.

The S&P 500 is just above its 50-day moving average (blue line), and one more day of selling will push it under the line and establish a short-term downtrend. The next major support is at the black line at 1,300, which is drawn on the February low, the April low, and the June pre-breakout high. Note that the Moving Average Convergence/Divergence (MACD)[2] indicator is arching down and that the indicator is declining from its highest level of the year following the sudden rally of two weeks ago.

Yesterday, the U.S. dollar via the PowerShares DB US Dollar Index Bullish Fund (NYSE: UUP[3]) broke above its June high. It is now threatening the May 23 high at $21.86 and its 200-day moving average at $22.15, which if penetrated on high volume, could change the overall direction of U.S. stocks and commodities.

Regarding the Financial Select Sector SPDR (NYSE: XLF[4]), I noted on July 7, “The first test was when the index broke through $15.24. The real test will come when the XLF reaches the broad resistance at $15.40 to $15.80.”

On Thursday, it almost reached the 200-day moving average, which is just under $15.80, but on Friday, it reversed lower, gapping down through its 50-day moving average (blue line). Yesterday, it fell even more on another gap down and now threatens the support zone from $14.57 (June low) to the former resistance at $15.24.

Conclusion: The late June rally was the strongest of the year — driving stocks up almost 6% in one week with an “overbought” reaction from each of our internal indicators. When this occurs, the market is setting itself up for disappointment. And when coupled with such highly charged issues as the termination of QE2, a very visible squabble between the political parties in the United States over the budget, and now a new euro zone crisis with Italy, the market is bound to become very volatile. Traders who decide to take the short side of the market should be very careful since the two major crises, the budget and Italian debt, could both be settled with the stroke of a pen.

It is time to wait, not to act. The overall trend is still up, and so patient bulls could be rewarded with surprising bargains.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[5].

For a list of this week’s economic reports due out, click here[6].

See Serge Berger’s Daily Market Outlook: 6 Charts That Show a Market Teetering on the Brink[7]

See Sam Collins’ Trade of the Day: Energy Stock Gearing Up For Major Move[8]

See Serge Berger’s Trade of the Day: AutoZone Stock Set to Rev Up Soon[9]